The Last Wild CAMELs

The mountains of Northern Mongolia are home to the world's last remaining, non-domesticated camels. Apart from being a tourist find, the camels' thread-like existence displays man's ability to harness and thereby tame these most wonderful creatures, as well as their ability to survive.

Bank and country risk analysts have lived with CAMELs (as opposed to camels) for decades. CAMEL or Capital, Assets, Management, Earnings and Liabilities comprised the 1950's benchmark analysis used to probe every major business entity for the last 60 years. However, as much as companies, banks and countries have changed, the CAMEL, like its antecedent, has not.

This domesticated CAMEL was founded at a time of prosperity, when banks were "too big to fail," and countries did not go bust - a cosseted period when government risk was considered "no risk". A time when the 3-6-3 principle prevailed: "Take in money at 3%, lend it out at 6% and hit the golf course by 3 o'clock."

CAMEL has survived virtually untouched by mankind. Regardless of the defaults in Latin America, rescheduling in Western Africa, the crumbling of the Soviet Union, and Far East meltdowns, there seems to be no financial Armageddon that this tenacious beast can't slowly digest in its copious stomach. However a closer look at its gene makeup does reveal some incredible, self-destructive DNA.

To begin with, capital has not been a performance indicator. Capital merely evidences a bank's response to external regulation. No bank has ever failed because of lack of capital. It is increasingly irrelevant in state economies where it merely represents yet more public money being used to shore up non-performers. In fact, capital has been so ineffective as a regulator that Basle stands at an all-time low in the opinion polls of the world's leading banks.

Secondly, assets have never been an indication of wealth. When Japan owned 25% of the world's banking assets and seven of the top ten banks, those assets, now increasingly failing, were mere indicators of the ability of banks to grow their loan portfolios by taking on higher risk assets; or by not analysing them properly. In fact, it is the quality of the decision-making process to put those assets on the books which is a real, contemporary performance indicator used by all top analysts.

Another word for the CAMEL process is management. This is why banks and countries go bust - the decision-making processes of this cadre. In sovereign risk analysis we call managers politicians, but as countries increasingly look like large companies, the risk is the same. In fact, CAMEL is management because every component part of CAMEL is about management and its decisions.

For example, take liabilities. As a bank's loans are its assets, the liability section is all about the decisions management take in funding that loan-book. Maybe they will utilise a loyal deposit base of safe money, rely on bulk deposits from Multi-National Corporations, or run cap-in-hand to their competitors on the Interbank market - it is all about decision-making. Liabilities do not just happen; they must be controlled. Cost/Income ratios are one of the most revealing groups of analytical tools that can be applied to an organization: if a bank cannot control its costs, it is certain that other areas of the bank's balance sheet will be running out of control in an overall "loose" control culture. If Bank X is running a high Interbank Book, then the cost of its money will be excessive and end up exposed on the Income Statement.

Earnings, income, profit, the bottom line...call it what you will. HOWEVER, a historic record of how much a bank made in 2001 or even in the first quarter of 2002 bears no relation to its overall performance next year. If any area of a bank's balance sheet is subject to its environment, this is it.

So, how has the CAMEL survived?

The reality is that the most effective and contemporary analysts simply do not use it very often. CAMEL has acquired "icon" status in the financial world similar to, "give them 10% of their Tier One capital as a spot line" and other anachronistic benchmarks.

Questions today start with the figures and then "look behind them" to discover the reality of current management thinking based on the knowledge that every figure can be looked at two ways. A hidden provisions figure may seem to enter "comfort" zone territory like a "stash fund" or "Christmas Club." After 23 years and 2000 analyses of banks, they seem to the writer to be more like a shoddy attempt to shore up next year's figures (which we know are going to be bad) with the results of a previous, better year. Every component part must be similarly viewed in all its positive and negative facets. The process is more like a detective's investigation than a CAMEL.

And the next time you are in Northern Mongolia - do check out these magnificent Bactrians.

Howard Palmer is the Course Director for the FT Knowledge Financial Learning course:

Financial Country Risk
18-Nov-2002
Washington D.C.

See the course agenda, description, and special offer!